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Morningstar | PetroChina Is Fairly Valued Despite Earnings Recovery; Dividend Yield Remains Decent

PetroChina is the listed arm of one of China's two integrated oil majors and the largest oil producer. With revenue and assets more heavily weighted toward the upstream activities, PetroChina is more sensitive to oil price swings than its peer, Sinopec. In addition, the firm’s downstream operations lag behind Sinopec, which has better scale and efficiency in the sector. That said, PetroChina will benefit more in a rising oil price environment.While we believe that government restrictions on domestic exploration by foreign firms have given PetroChina a clear advantage in securing oil and gas reserves in China, the lack of large discoveries and the structural decline in legacy oilfields have led to a decline in total reserve life to about 14 years in 2017 from about 17 years in 2012. As a result, the company is forced to secure resources overseas. It is common practice for China National Petroleum, PetroChina’s parent, to acquire, develop, and inject high-quality projects into PetroChina at below-market prices. As CNPC buys up assets in South America, Central Asia, and Africa, we expect it to drop down some of these projects when they mature.PetroChina owns 70% of China's oil and gas pipeline network and is looking to spin off these midstream assets. The sales should enable the company to reduce its capital expenditure commitment and recognize a higher valuation for the assets. The additional cash flow will also help the company offset lower contribution from its upstream operations in a low-oil-price environment.Being a state-owned monopoly has hurt the firm financially, as it is obligated to import natural gas at a higher cost than it can sell it for. Consequently, margins at PetroChina’s natural gas pipeline segment suffer when prices rise. As China shifts its focus away from subsidizing the industrial sectors toward encouraging private consumption and reducing pollution, reforms should allow prices to move more closely with international benchmarks. We expect the continued rollout of natural gas pricing reform to help PetroChina stage a gradual margin recovery.